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On a day when inflation surprised to the upside, it was timely for the CFA Society of Chicago to host Bob Michele, Chief Investment Officer, and Head of Global Fixed Income, Currency & Commodities group (GFICC) of J.P. Morgan Asset Management.  James Mohan, CFA, co-chair of the Distinguished Speaker Series (DSS) Advisory Group of the Society, moderated the conversation with Michele.  The group convened at the LaSalle Club to hear Michele’s insights over lunch.

Mohan eased into the conversation by asking Michele questions about himself.  We learned that his hobbies include swimming and bogie golfing.  Michele’s most powerful advice of the day was to buy the book “The Fund,” about an investment management outfit called Bridgewater.  He insists that you will not be able to put it down.

When asked to impart wisdom that aided him greatly in his career, Michele said to do your own research.  He recalled that, as a younger analyst at Brown Brothers Harriman, he would go to the New York Federal Reserve to buy the Fed’s “Tan Book,” as the Beige Book was formerly known, to pore over the data firsthand.

Michele sees today’s economic situation as analogous to that of 1995.  The Federal Funds rate increased 300 basis points from February of 1994 through February 1995.  The increase over that time is less than the 525 basis point increase from early 2022 through late 2023, but the end points (5.25% more recently compared to 6.00% in 1995) are fairly similar.  There were stresses in the market in the mid-90s… US Steel defaulted, Mexico suffered the Tequila Crisis, and Orange County, California defaulted on municipal bonds.  That is, there was a lot to worry about then, just as today we have persistent inflation, increasing government indebtedness, and a commercial real estate market on the verge of material impairments.

 In 1995, the Fed cut a few times from the 6% peak, but the Fed Funds rate had a 5-handle for around three more years.   The US Central Bankers were able to engineer a soft landing through this time.   Michele sees history potentially repeating itself, with another soft landing pulled out of the hat, an outcome that he admits he doubted, not long ago, could be achieved.

Michele expects only a couple of Fed Fund Rate reductions this year, and believes that is all that is necessary to maintain a steady recovery.  He doesn’t think deeper cuts are required in the face of stubbornly high inflation, because there is not an economic problem that requires such measures.   Commercial real estate seems to be resolving itself, in his opinion, so massive rate cuts are not needed to bail out that sector, banks and the economy broadly.

Should the economy start to wobble, Michele pointed to new source of stabilization… private credit.  Once vilified by capital markets pros (Michele quoted Colm Kelleher as having once referred to private credit as the evil in the industry) Michele now considers the industry a legitimate non-bank lender.  Michele went on to explain that this asset class could be an essential source of capital in the next downturn, with hundreds of billions of lending capacity in private credit funds being undeployed.  That dry powder will supply capital when borrowers need it most, Michele explained.

Michele provided figures to illustrate the growing importance of this asset class.  In 2007, the public high yield market was $700 Bn; syndicated credits were a couple hundred billion; and private credit was near zero.  Today, the public high yield market is $1.7 Trillion; syndicated loans are $1.5 Trillion; with Private Credit funds at $1.7 Trillion, with hundreds of billions of those private credit funds not yet deployed.

Mohan asked Michele what areas of the economy he perceives as weak.  “The Consumer is not the problem,” Michele responded.  And Michele believes banks have exited the crucible, supported by the Bank Term Funding Program.  He pointed to deposit growth as a sign of a healthy banking system.  Michele went on to cite corporate America and Corporate Europe as “looking great.”

Michele singled out small and middle market companies in America as the space to worry about.  Pressure from increasing borrowing costs is intense.  Michele provided a specific example of a low-margin business which has seen its borrowing costs surge since COVID.  While this business eventually received a loan, Michele suggested that the lender is counting on higher margins to service the debt.  Michele would not count on expanding margins in this business.

Mohan steered the conversation toward the US Dollar.  Michele travels internationally, meeting with heads of sovereign wealth funds, pension funds, currency reserve funds, etc.  He always asks the heads of these funds what their secondary reserve currency is, after the USD.  Michele told us that he never receives an answer.  That is, for the clients he talks to, the US Dollar is the only game in town.  An audience member later asked Michele if there was a level of debt to GDP for the US, at which these international clients would worry about the USD, and at which he would start to rethink asset allocation and duration in his portfolios.  He answered that neither his clients, nor he, care about the ratio of federal debt to GDP.   His view is that borrowing on the part of the US government will only spur economic activity or enhance productivity.  To your reporter, this had an unexpected ring of Modern Monetary Theory (MMT). 

To summarize, Michele described a favorable economic outlook… a couple Fed Funds rate cuts this year… the 10-year staying below 5%… a healing banking system and CRE market.  He surely calmed some nerves on a day that started with an unwelcomed inflation surprise.